Where We Are – Surety Bond Market Trends
These last few years have been good ones for the Surety Bond Industry. We expect this market to remain strong through the second half of 2022, and so far we see no reason not to expect this to continue through this year.
This strength provides for what is known as a “soft” market. So, you ask, what is a soft market and what factors contribute to creating this sort of market? A “soft” market describes the situation where surety underwriters broadly provide more liberal offers as a means to acquire greater market share and obtain and retain quality clients. Typically, we see a general loosening of the terms the sureties offer in three areas: pricing, size of the credit facility, and indemnity. Each of these areas could provide an opportunity to contractors with strong balance sheets and a history of profitability.
Why We’re Here
First and foremost, surety losses remain low. Also, reinsurance is available to the surety industry at what are considered to be historically inexpensive rates. With sureties able to transfer greater amounts of risk at low rates, they become more aggressive in pursuit of market share. All of that creates a high level of competition, providing underwriters with the impetus to improve their terms for existing profitable accounts.
As is the case in any industry experiencing increasing profits, new players are also entering the market. Add that factor to an aggressive industry core, and you can understand how the greater capacity translates into a soft market.
The Back Story
Behind all of this, of course, is the continued strength in the construction market. Activity is stable, and margins seemed to have recovered although generally not to pre-recession levels. So long as there is continued stability in the market and contractors remain vigilant in their business practices; we would expect a steady pace of activity. The caveat should be that sometimes when capacity is growing at a faster rate than the demand; underwriters can become too aggressive and can take on too great an amount of risk. Moreover, we’ve seen a few significant “one-off” claims losses recently that demonstrate that thought.
The Risk
The surety industry detests risk. The main reason is that in surety, the potential losses can be huge compared to the premium charged. Imagine a site contractor on a $15mm project that paid $150,000 for his bond. The chances are that if there is a problem resulting in insolvency, the costs to be incurred by the surety to complete the project will far exceed the amount that can be recovered. Hiring a replacement contractor, fixing substandard work, legal costs, etc. all add up quickly. It doesn’t take many losses for a surety to consume a substantial amount of its prior profits.
When’s the Right Time
Fortunately, this positive business cycle has lasted a long time, perhaps longer than anyone expected. Again, we think the market is stable to growing. However, there’s reason for caution. The influence of politics on the business climate has never been so great, and we all know the political winds can swirl one day to the next. We’re cautioning clients to lessen their risks to bank lines of credit and to take advantage of low-interest rates while we have them. Should the economic winds change direction, banks have been known to have a change in appetite and begin to call LOC’s as they try to limit their own risk to the construction industry. When that happens, contractors can be caught with no time or market to support refinancing.
What To Do Now- Shine Up That Balance Sheet
So how does this translate to users of surety bonds? We’re in a strong mid-to-late cycle. Your jobs should be going well and you should be pushing to expand margins taking on the most lucrative work you can possibly get. It’s also a great time to polish up your balance sheet. Retain your earnings. Pay off debt. Restructure your short-term debt by terming out as much as you can at these low rates and lessening your vulnerability to your bank line of credit. Improve your working capital.
And when that’s done you should be asking yourself whether your surety agent talked with you about positioning your company to maximize your surety credit line and terms. Because now is the time.
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